Dividend Strategy With Quality Yields – The Dow Jones U.S ...

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Dividend Strategy with Quality Yields ? The Dow Jones Dividend 100 Indices

Contributors

Tianyin Cheng Senior Director Strategy Indices tianyin.cheng@

Izzy Wang Senior Analyst Strategy Indices izzy.wang@

INTRODUCTION

Dividend-paying stocks have been in focus over the past decade--many income seekers have turned away from low-yielding fixed income instruments and are looking to equity markets for a more attractive level of income. However, high-yielding companies without strong financial stability may be prone to dividend cuts under the pressure from global economic uncertainties and future rising rates. Thus, an investment strategy searching for high yield should focus on quality as well.

Vinit Srivastava index_services@

Karina Tjin index_services@

Among different kinds of income-focused equity indices in the market, the Dow Jones Dividend 100 Index Series takes a unique approach. It seeks to track the performance of 100 high-dividend-yielding stocks in each market covered that have a record of consistently paying dividends, selected for solid fundamental strength.

S&P DJI launched the Dow Jones U.S. Dividend 100 Index in 2011. Recently, we expanded the index series to international markets with the launch of the Dow Jones International Dividend 100 Index. This paper investigates the following potential benefits of the Dow Jones Dividend 100 Indices.

? Sustainable dividends with financial quality. The indices not only seek to track stocks with consistent dividend payouts, but they also apply a quality screen for the sustainability of yields. They seek to achieve "quality yields" by requiring stocks to have paid dividends for a minimum of 10 consecutive years, and by ranking stocks by a composite score calculated from the cash-flow-to-totaldebt ratio, return on equity (ROE), dividend yield, and five-year dividend growth rate. In addition to the fundamental annual rebalancing, starting from July 2018, S&P DJI introduced a monthly dividend review as an on-going maintenance to ensure dividend sustainability. Every month, stocks that have canceled their dividends will be removed from the indices.

? Dividend growth against future rising rates. A focus on dividend growth in an environment where market participants are concerned

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Dividend Strategy with Quality Yields ? The Dow Jones Dividend 100 Indices

August 2021

about rising rates may be important. Typically, high-yield equity strategies are biased toward rate-sensitive sectors, which tend to pay out higher yields because of the leverage that they can take on (mainly because of mature business models; e.g., Utilities). Such entities are exposed when rates rise. Selection based on dividend growth helps to ensure that firms that can develop their business and increase their payouts are favored in the selection process. Such businesses are often well-managed companies, from both capital structure and operational perspectives.

The Dow Jones Dividend 100 Indices not only seek to track stocks with consistent dividend payouts, but they also apply a quality screen for the sustainability of yields.

? Investability. Differentiating the Dow Jones Dividend 100 Indices from other dividend strategies are their strict size and liquidity screens and their weighting method, which is based on a modified market capitalization approach. These attributes were chosen with the goal of increasing index investability in terms of liquidity, capacity, and turnover. Size and liquidity screens could help to reduce the influence of smaller and more distressed stocks on the portfolio, leading to a liquid basket of constituents. A weighting method based on modified market capitalization could not only help maximize the index capacity, but it also has potential to lead to a lower turnover than alternatively weighted income indices, that weight constituents primarily by yield or total dividends.

Exhibit 1 summarizes the construction methodology and ideas behind the Dow Jones Dividend 100 Indices, which seek to balance yield, quality, capacity, and diversification.

Exhibit 1: Construction Methodology for the Dow Jones Dividend 100 Indices

CATEGORY

INDEX METHODOLOGY

INTENDED TARGETS

El i g i bil ity Sc reen i ng

Yield Selection

Fun d amental Sel ec ti o n

W ei g hti ng

Mo n th ly Dividend Review

Screens for dividend payment consistency, size, and liquidity:

? Minimum 10 consecutiveyears of dividend payments

? Minimum float-adjusted market capitalization of USD 500 million

? Minimum three-month average daily trading volume of USD 2 million

Stocks that pass the screens are ranked in descending order by indicated annual dividend yield. The top half are eligible for selection. Stocks are then ranked by a composite score of cash-flow-to-total-debt ratio, ROE, dividend yield, and five-year dividend growth rate. The top 100 are selected as constituents. Stocks are weighted by market capitalization, and they are subject to a 4% individual stock weight cap and a sector weight cap (25% for U.S. and 15% for international markets) Monthly dividend review to remove stocks that have canceled or suspended their dividends

? A prerequisite of tradability by screening for a stock's capacity and liquidity

? A requirement of consistent dividends by screening for stocks that have paid dividends for a minimum of 10 consecutive years

A focus on absolute yield by owning the highest-yielding stocks that pass the size, liquidity, and dividend payment consistency screens An emphasis on the quality factor, which is relevant when considering a company's ability to generate free cash flowso thata dividend can be sustained and potentially increased An attention to representativeness by using a modified market cap weighting so that distressed smaller-cap firms don't dominate the strategy

An on -going maintenance to ensure dividend sustainability

Rebal an c ing

Annual rebalance in March

A key element for reducing turnover

Source: S&P Dow Jones Indices LLC. Table is provided for illustrative purposes.

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Dividend Strategy with Quality Yields ? The Dow Jones Dividend 100 Indices

August 2021

The Dow Jones Dividend 100 Indices delivered better yields and capital gains over the long term when compared with their benchmarks.

RETURN FROM DIVIDENDS AND CAPITAL GAINS

The two things that market participants tend to care most about when using any income strategy are yield and capital gain. The constituents of the Dow Jones Dividend 100 Indices have delivered both better yields and better capital gains over the long term when compared with the constituents of the benchmarks.

For the period between June 30, 2001, and June 30, 2021, the price return of the Dow Jones U.S. Dividend 100 Index was 8.1% annualized, outperforming its benchmark's 7.1%, as measured by the Dow Jones U.S. Broad Stock Market Index. The total return of the index, which assumes theoretical reinvestment of dividends, was 11.8% annualized, outperforming the 9.1% total return of the benchmark (see Exhibit 2).1 Likewise, the international version, the Dow Jones International Dividend 100 Index, outperformed its benchmark, the S&P Global Ex-U.S. LargeMidCap, in terms of price return and total return over the past 15 years.2

The difference between the total return and the price return represents the dividends paid out, although the effect is a bit magnified due to capital appreciation of the theoretical reinvested dividend portion. For the Dow Jones U.S. Dividend 100 Index and the Dow Jones U.S. Broad Stock Market Index, the difference was 3.7% and 2.0% over the past 20 years, respectively. For the Dow Jones International Dividend 100 Index and the S&P Global Ex-U.S. LargeMidCap, the difference was 4.7% and 3.1% over the past 15 years, respectively. The Dow Jones Dividend 100 Indices had a higher yield spread over time.

1 The Dow Jones U.S. Dividend 100 Index was launched on Aug. 31, 2011. The foregoing information is based on back-tested data. 2 The Dow Jones International Dividend 100 Index was launched on March 22, 2021, with its first value dated back to March 31, 2005.

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Dividend Strategy with Quality Yields ? The Dow Jones Dividend 100 Indices

August 2021

Exhibit 2: Risk/Return Profiles

U.S.

PERIOD

DOW JONES U.S.

DIVIDEND 100 INDEX

TOTAL

PRICE

RETURN RETURN

DOW JONES U.S. BROAD

STOCK MARKET INDEX

TOTAL

PRICE

RETURN RETURN

ANNUAL RETURN (%)

INTERNATIONAL

DOW JONES INTERNATIONAL

DIVIDEND 100 INDEX

TOTAL

PRICE

RETURN

RETURN

S&P GLOBAL EX-U.S.

LARGEMIDCAP

TOTAL

PRICE

RETURN RETURN

3-Year

19.35

15.22

18.71

16.64

14.93

10.00

10.09

7.00

5-Year

16.47

12.61

17.86

15.73

12.97

8.23

11.73

8.56

7-Year

13.76

10.05

13.93

11.82

7.79

3.27

6.00

2.96

10-Year

14.68

11.02

14.68

12.50

9.03

4.43

6.08

3.00

15-Year

12.27

8.58

10.88

8.75

8.44

3.77

5.52

2.44

20-Year

11.77

8.05

9.09

7.07

-

-

-

-

ANNUAL VOLATILITY (%)

3-Year

18.89

18.80

19.44

19.44

15.28

15.29

17.45

17.54

5-Year

15.43

15.36

15.66

15.66

12.98

13.00

14.46

14.55

7-Year

14.31

14.24

14.75

14.75

12.81

12.81

14.40

14.44

10-Year

13.13

13.09

14.16

14.15

12.73

12.76

14.99

15.07

15-Year

14.59

14.59

15.66

15.67

15.05

15.00

17.67

17.66

20-Year

13.64

13.62

15.20

15.19

-

-

-

-

RISK-ADJUSTED RETURN

3-Year

1.02

0.81

0.96

0.86

0.98

0.65

0.58

0.40

5-Year

1.07

0.82

1.14

1.00

1.00

0.63

0.81

0.59

7-Year

0.96

0.71

0.94

0.80

0.61

0.26

0.42

0.21

10-Year

1.12

0.84

1.04

0.88

0.71

0.35

0.41

0.20

15-Year

0.84

0.59

0.69

0.56

0.56

0.25

0.31

0.14

20-Year

0.86

0.59

0.60

0.47

-

-

-

-

MAXIMUM DRAWDOWN (%)

15-Year

-44.47

-47.44

-50.84

-52.34

-49.58

-52.66

-56.84

-58.53

Source: S&P Dow Jo nes Indices LLC. Data as of June 30, 2021. Past performanceis no guarantee of future results. Index performance based on total and price returns in USD. Table is provided for illustrative purposes and reflects hypothetical historical performance. Please see the Performance Disclosure at the end of this document for more information regarding the inherent limitations associated with backtested performance.

The back-tested data in Exhibit 2 show that the Dow Jones Dividend 100 Indices delivered higher total returns than their respective benchmarks over the short- and long-term horizons. The indices also showed reduced risk, as measured by volatility and drawdown. As a result, the historical outperformance may be considered higher in terms of risk-adjusted returns. Over the past 15 years, the risk-adjusted total returns (the ratio of total annual return to annual volatility) of the U.S. and international versions were 0.84 and 0.56, respectively, which were significantly greater than that of their respective benchmarks. We believe this effect may come from the defensive nature of the income strategy and the quality tilts that are uniquely carried by the Dow Jones Dividend 100 Indices.

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Dividend Strategy with Quality Yields ? The Dow Jones Dividend 100 Indices

August 2021

The Dow Jones Dividend 100 Indices demonstrated improved financial strength in terms of profitability compared with their benchmarks.

QUALITY

With their focus on the quality factor during stock selection, the Dow Jones Dividend 100 Indices demonstrated improved financial strength in terms of profitability and earnings quality compared with their benchmarks (see Exhibit 3).

Exhibit 3: Improved Financial Strength

U.S.

17.5 16.7

13.7

12.6

Inte r national 14.0 11.4

The Dow Jones Dividend 100 Indices showed reduced risk, as measured by volatility and drawdown.

7.6

6.5

3.8 2.5

1.0 1.5

ROE

Net Margin

Earnings Variability

ROE

Net Margin

Earnings Variability

Dow Jones U.S. Dividend 100 Index

Dow Jones International Dividend 100 Index

Dow Jones U.S. Broad Stock Market Index

S&P Global Ex-U.S. LargeMidCap

Source: S&P Dow Jones Indices LLC and FactSet. Data as of June 30, 2021. Past performance is no guarantee of future results. Earnings variability is calculated as the standard deviation of EPS over the

past five years. Charts are provided for illustrative purposes and reflect hypothetical historical performance. Please see the PerformanceDisclosure at the end of this document for more information regarding the inherent limitations associated with back-tested performance.

As companies with financial stability are more likely to endure difficult economic environments, quality tilts may provide some downside protection during depressed times. Since 2000, the Dow Jones U.S. Dividend 100 Index outperformed the benchmark in each of the major equity market drawdowns (see Exhibit 4). While lacking data during the Tech Bubble, the international version significantly outperformed its benchmark during the Global Financial Crisis, Q4 2018, and the recent 2020 COVID-19 sell-off.

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